CVS Health stock (NYSE: CVS) has seen a fall of 10% in a month, compared with -5% returns for the broader S&P500 index. The company reported upbeat Q4 results last month, with revenue and earnings well above our estimates. Still, CVS stock trended lower due to lower-than-expected guidance for 2024, when the company will face the impact of lower Medicare Star ratings. After its recent fall, we believe CVS stock is undervalued.

CVS Health's revenue of $83.8 billion in Q4 2022 reflected a 9.5% y-o-y rise, with growth in all segments. Health Care Benefits and Pharmacy Services sales were up 11% y-o-y, while Retail sales were up 4%. The company benefited from a rise in Medicare and Commercial membership to 24.4 million by the end of 2022, compared to 23.8 million in 2021. Total pharmacy claims processed rose 3.1% in Q4, bolstering the sales growth for the Pharmacy Services segment. Its medical benefits ratio (MBR) also improved to 86%, vs. 87% in the prior-year quarter. However, its adjusted operating margin declined by 60 bps during the quarter.

The company has guided sales growth to be between 3% and 5% and its adjusted EPS to be between $8.70 and $8.90 in 2023. CVS will also benefit from its proposed acquisitions of Signify Health - a home healthcare services company - and Oak Street Health - a medicare focused primary care provider. However, CVS will likely see slower growth in 2024 due to medicare star rating headwinds. In October last year, CVS saw a downgrade in its most extensive health insurance plan for Medicare patients, with 1.9 million members. The reduced rating implies the plan's ineligibility for performance-based bonus payments from the government in 2024. The company has guided EPS to be around $9.00 in 2024, rising to $10.00 in 2025, implying only a modest growth between 2022 and 2025. This did not sit well with the investors, as evident from stock performance in recent months.

Given the recent decline in CVS, we see nothing but opportunities. Looking at valuation, at its current level of $77/share, CVS stock is trading at just 8.7x its 2023 expected earnings of $8.83 (FactSet). For the past 5 years, this forward multiple has been 10x, implying that CVS stock is currently undervalued. We expect in the upcoming months, the forward multiple will normalize back up towards trend (10x rather than currently 8.7x). Applying a 10x foward multiple to $8.83 per share earnings in 2023, we arrive at our price target for CVS to be $88 per share, representing a 14% upside in the stock from current price of $77/share. Looking out to 2024, based on $9.24 estimated earnings, we can see shares trading at $92/share. 

Given its transformation from a retail pharmacy to a broader healthcare provider, we are very confident that this normalization is a matter of when, not if. Its new acquisitions will further strengthen its business and help expand its net margins, resulting in solid earnings growth beyond 2024.